Distressed debt a new asset class in Asia

Distressed debt a new asset class in Asia

By Andrea Ricci

HONG KONG (Reuters): Asia's decline in fortunes has created a
new class of securities previously associated with troubled Latin
economies but not robust Asia -- distressed debt.

With currencies of many countries sharply weaker, numerous
companies have found themselves unable to service their external
debt, forcing them to restructure or default.

Many more are current on their obligations but are the victims
of poor sentiment, which has caused Asian debt paper prices to
plummet.

The debt of all of these companies can be considered
distressed. And there are investors who will take it.

So investment banks are taking a closer look.

"I wouldn't say that it is a change in focus for us," said
Ivan Lee, vice president and head of fixed-income research at
Salomon Smith Barney.

"I would say that the distressed debt market is attractive
enough for us to have a serious look at the market and put some
resources there," he said.

Raja V, vice president at BA Asia, said distressed debt is not
easy to define but can be split into three broad categories.

"The first category are those companies that are going through
a prolonged period of illiquidity. In this category, all you are
looking for is the catalyst that turns them from being illiquid
into liquid and viable investments," said Raja.

The second type are companies that have been growing beyond
sustainable growth rates and are overextended financially.

"These are the ones that an investor is really looking at from
the point of view of M&A (mergers and acquisitions) activity or
assets sales, normal corporate restructuring," he said.

The third are companies that are "pure and simple junk. What
you are looking for there is terminal asset values", he said.

Salomon's Lee said many bonds and loans in Indonesia are
distressed in terms of their yield spreads.

"Have they defaulted? No. They are still current. But because
of the perceived risk of the parent, the trading level can be
distressed," he said.

Potential returns with distressed debt are high, but so are
the risks. Investors take on distressed debt in the hope that the
big money that can be made on a few deals will make up for losses
on the rest.

Most investors are U.S.-based funds that have experience with
distressed Latin American debt or got into the market in the late
1980s when the U.S. real estate market tumbled.

Asian investors are just starting to get into the game.

Both types of players have something to learn.

"There are Asian players that are not used to buying
distressed debt, but they know the Asian market," said Douglas
Tanner, senior partner in Asia for Milbank, Tweed, Hadley and
McCloy, a law firm advising debt holders and investors.

"Then you have a lot of people in the U.S. which are very
sophisticated buyers of distressed debt, but they don't know
anything about Asia. So over the last three months it has been a
process of education on both sides, one learning about distressed
debt, the other learning about Asia," he said.

Investment banks are gearing up for the nascent market,
putting more resources into credit research.

"You have to have good traders or good salespeople that can
source paper, or you need to have a lot of people that are very
close to the companies, who would know what their funding profile
is, what their funding gaps are and therefore would know what
money they need and when they need it," said a fixed-income
manager at a U.S. bank.

"It is very detail-oriented sort of stuff, it's not sexy, it's
not glamorous. People think it is, but there is actually a lot of
drudgery that goes into making money in it," he said.

The same problems that plague Asian debt markets generally --
a lack of transparency, poor corporate disclosure and unclear
bankruptcy laws -- become magnified when the debt in question is
distressed. Clarity varies significantly by country.

"If you look at Hong Kong and Singapore, the legal recourse
available to the creditors is very comfortable and the disclosure
level in terms of the integrity of the financial statements is
quite reliable," said Lee.

"When you get into countries like Thailand and Indonesia,
where the bankruptcy laws are still being developed, the
uncertainties there obviously are higher. And Malaysia and Korea
are in between," he said.

How much clout debtholders have in forcing a company to
restructure also varies by country, and by company.

"If you have a company that needs to do an international
financing to continue to expand its business or to meet its
obligations then the holders of its existing debt have a lot of
leverage," said Tanner.

But, he said, "I have not seen evidence that holders of
distressed debt have been able to exercise substantial leverage
out here in Asia."

The outlook for improved bankruptcy laws is good, however.

"By and large, the legal systems are converging on the U.S.
style, which is one of the reasons that many of the vultures
swooping around are Americans," said the fixed-income manager.

Other factors also can cloud the picture, analysts said.

"Sometimes, there is a discrepancy of information, so that
investors think the debt is hedged and then find out it's not,"
said C.K. Kong, vice president, Pacific credit research, at
Credit Suisse First Boston.

Salomon's Lee said the supply of Asian distressed debt
ultimately could be in the tens of billions of dollars. But trade
is as yet modest and liquidity very thin.

"The market is very new and not well developed. A lot of
investors are doing their homework at this stage and are very
selective," Lee said.

Existing creditors, meanwhile, are still deciding whether they
want to sell their portfolios.

Some investors have complained that Asian distressed debt is
too richly priced, a problem Lee attributes to existing
creditors' unwillingness to sell the debt at a deep discount.

"We are seeing quite a lot of interested buyers, but they are
not aggressively buying, which is an indication that they think
the price is on the expensive side," he said.